Traders use two methods when evaluating the value of assets— technical analysis and fundamental analysis. Technical analysis focuses on patterns and past trading movements. On the other hand, the fundamental analysis relies on the intrinsic value of assets based on the financial markets and economic factors.
Whether you’re a beginner trader or a professional, there’s always the possibility that you need to use fundamental analysis when trading. In this article, we’ll help you get started with understanding fundamental analysis and its importance.
What is Fundamental Analysis?
Do you already have an idea of how to trade shares, cryptocurrencies, and bonds? Now that you’re ready to learn about fundamental analysis, you should know that it’s used to assess the true value of the mentioned financial instruments.
The main purpose of using fundamental analysis in trading is to identify whether an underlying asset is overvalued, fair, or undervalued.
Meanwhile, fundamental analysis is composed of two factors, qualitative and quantitative. The qualitative factors are information gathered from figures, numbers, and charts. On the other hand, the quantitative factors are from the standard, quality, and the less tangible things.
Critical Aspects of Fundamental Analysis
1. Company’s Financial Statement
One of the vital factors in fundamental analysis is the financial statement. It includes the cash flow, income statement, and balance sheet of the company that can help traders and investors identify whether a company is financially healthy or not.
2. Revenue Growth
As an investor, it helps to feel at ease when there’s constant revenue growth, steady sales, and profit. On the other hand, if a company can’t provide great results financially, it’s hard to trust them with your money and trading portfolio.
3. Competitive Advantage
Does the company hold a strong brand? When a company is holding something like a technology or patent, it can assure investors of long-term success. In addition, the company should also have the ability to outperform its competitors.
For instance, if you’re interested to know how to trade shares of the Coca-Cola Company, you should know all their competitive advances before trading.
4. Management Team
A company can’t grow and continue to make a profit if the management team isn’t as reliable as expected. As you know, effective management has a great impact on the overall performance of a company, and if the team can’t maintain a great performance, investors may doubt their capabilities. This may also be one of the reasons why the market tends to be shaken up when the CEO of the company changes.
5. Market Trends
When using fundamental analysis, an investor or trader also considers the market trends and the status of the industry. Although they’re not directly happening in the company, certain changes or advancements in the market may greatly affect its performance.
For instance, if there’s an issue in the oil industry, every oil company is also affected worldwide.
The Importance of Fundamental Analysis
1. Making an Informed Investment Decision
As a trader or investor, one of the decisions you have to make is to choose if you’re going to hold, buy, or sell. When using fundamental analysis, it’s easier to make an informed decision since you’re aware of the value (overvalued, undervalued, or fair) of an underlying asset.
2. Long-term Investment
Aside from making an informed decision, using fundamental analysis can encourage you to invest long-term. In addition, it lessens the idea to speculate and rather focuses on the growth and strengths of a company you’re interested to invest in.
When that happens, it’s easier to obtain a better portfolio and create a sustainable trading plan.
3. Risk Management
If you evaluate the financial health of the company, it can help you assess the risks you might face when investing. So, it’s not all about finding the strengths and positive sides of a company, but also mitigating the risks and protecting your capital.
4. Value Investing
Did you know that the strategy of value investing came from fundamental analysis? Value investing is a strategy when traders or investors buy undervalued assets believing that their true value will be recognised in the market over time.
Meanwhile, if the share is overvalued, traders usually sell the stock in case it goes higher the next time.
5. Achieve Realistic Expectations
Fundamental analysis is a great way to set realistic expectations about the performance of your investments. If you fall under trends, hypes, and other speculations, it may create a negative impact on your investment. Instead, create a strategic trading plan based on fundamental analysis that usually leads to positive outcomes.
Although learning about fundamental analysis may take a while, it can serve as a powerful tool to create a better investment plan. However, it’s not the only thing you need to learn when achieving constant profit. You can also incorporate technical analysis and risk management for a more successful result.
We hope this article helps you to get started with understanding fundamental analysis and its importance in trading and investing. If you want to add more to the discussion, kindly leave a comment below!
ABOUT THE AUTHOR
Aliana Baraquio has over 5 years of experience as a writer and market analyst. She specializes in developing beginner-friendly trading techniques and tutorials. Additionally, she suggests FP Markets as the top broker for trading CFDs and Forex.